FOCUS: Growing Pains From Regulators Give Small Banks Pause

--Growing bigger than $10 billion in assets is "like going from junior high to high school" for banks, says Lawrence Kaplan of law firm Paul Hastings Janofsky & Walker
--In "most unusual" decision, Prosperity turned away deposits
--"You don't always have to be bigger to be more profitable," says Citizens Republic CEO Cathleen Nash


NEW YORK (Dow Jones)--New regulations have led some banks to make the unusual decision of growing more slowly.

Expanding beyond $10 billion in assets comes with regulatory demands that are aimed at making the banking system safer but that add complexity and costs that could spur banks to lower the interest rates they pay for customer deposits in an effort to attract less cash.

"We think, for the time being, to be below $10 billion is important," Citizens Republic Bancorp Inc. (CRBC) Chief Executive Cathleen Nash said in an interview. "You don't always have to be bigger to be more profitable."

The newly created Consumer Financial Protection Bureau oversees bigger banks, requiring them to strengthen risk-management measures. Under a Federal Reserve proposal, they also would have to undergo an annual stress test to prove they can withstand economic hardship. Additionally, banks like Citizens Republic, with $9.5 billion in assets, are exempt from the Dodd-Frank financial-overhaul act's Durbin Amendment, which limits how much banks can charge merchants for debit-card transactions, providing smaller banks around $5 million in revenue.

"In some ways it's like going from junior high to high school," said Lawrence Kaplan, partner at Paul Hastings Janofsky & Walker, a Washington law firm that advises banks on strategic matters. "There is a major change. Even measured or prudent growth has consequences at a certain point."

To many banks, the threshold is arbitrary, but Kaplan said it's not a bad idea for some "to digest what they have." Requirements such as more risk-management committees may be appropriate for growing banks. So some banks "are figuring out, 'Do we have the infrastructure?'" In some ways, the processes set in motion once banks pass $10 billion are "a good, prudent management tool," Kaplan said.

Nash said her bank's board "would certainly like to see the company grow." But for now, improving profitability is more important so Citizens is better prepared for the costs of expanding beyond $10 billion, she added. The Flint, Mich., bank only recently recovered from the damage caused by troubled commercial real estate loans.

Citizens' shares rose about 68% the last 12 months to $13.66.

Prosperity Bancshares Inc. (PB) Chairman and CEO David Zalman told customers last year to take about $300 million of deposits to other banks because he wants to keep his bank small.

"It is the most unusual thing I have ever heard of in my entire life," Zalman said in an interview. The Houston bank, with $9.8 billion in assets, also postponed completing two bank acquisitions, all to stay small.

This year, however, "there is no way we can stay under [$10 billion]; the Texas economy right now is doing extremely well" and customers have "more money in their accounts than ever before," Zalman said.

Prosperity's shares fell less than many banks', by around 2% the last 12 months to $40.18.

Gerard Host, CEO of Trustmark Corp. (TRMK) in Jackson, Miss., also worked on delaying passing the $10 billion mark. He told Dow Jones he called cash-rich customers in late 2011 to make sure their year-end deposits wouldn't push the bank over $10 billion.

"We have evaluated a number of different options" to offset the cost of reaching the threshold, including lowering interest rates Trustmark, with $9.7 billion in assets, pays for certificates of deposits or raising fees on some banking products, he said.

Deposits rose by more than $500 million last year. Trustmark National Bank Treasurer Mitch Bleske told investors last month, "We continue to be very disciplined on the CDs and ... our pricing."

Trustmark's shares fell around 2% the last 12 months to $23.87.

MB Financial Inc. (MBFI) CEO Mitchell Feiger said, "We are watching [deposit] accounts carefully." Chicago-based MB has $9.8 billion in assets. Its share fell approximately 5% the last 12 months to $20.08.

"We'll see what happens" in 2012, he said in an interview. "We work to stay under $10 billion until we can't do it anymore and we'll blow past it. When you go past it, it doesn't make sense to go over by $100 million."

Banks around $9 billion, "for the most part, all feel they need to be bigger," said Frederick Cannon, research director at investment bank Keefe Bruyette & Woods. But "the sweet spot is being in the $5 [billion] to $10 billion range. There is no real point in being a $12 billion institution."

Bankers said assets of $15 billion add enough scale to absorb the cost of growing. So a larger acquisition may be the solution.